THE AICPA ACCOUNTING AND REVIEW SERVICES
committee issued a proposed revision of
SSARS no. 1, Compilation and Review of
Financial Statements, in December 1999.
It gives accountants new communications
alternatives they can use when compiled
financial statements will be restricted to
management use only.

THE PROPOSAL DOES NOT PROVIDE AN
EXEMPTION from SSARS no. 1 or create
another level of service. An accountant would
still have to compile the financial statements
restricted to management’s use under existing
SSARS no. 1 performance standards.

A NEW DEFINITION OF “SUBMISSION OF
FINANCIAL statements” would exclude
the modification concept and instead focus only
on the generation of financial statements. The
new communication options the revision provides
would be appropriate only when the accountant
does not expect third parties to use the
financial statements.

ACCOUNTANTS WOULD HAVE TWO NEW
COMMUNICATION options available to
them: an engagement letter agreed to and signed
by management or a letter addressed directly to
management. These letters would include much of
the same information currently contained in the
standard compilation report.

THE ED DEFINES THIRD PARTIES AS ALL
PARTIES except members of management
who are knowledgeable about the nature of the
procedures applied and the basis of accounting
or assumptions used in presenting the financial
statements. This means some members of
management—those not knowledgeable about the
entity’s accounting matters—could be considered
third parties.

DIANE S. CONANT, CPA, is a partner of
Conant, Nelson & Conant, Ltd., in Las Vegas and
chairwoman of the AICPA accounting and review
services committee. Her e-mail address is diane@cncltd.com
. J. RUSSELL MADRAY, CPA, is a lecturer at
Clemson University School of Accountancy and Legal
Studies, in Clemson, South Carolina. He is a member
of the ARSC. His e-mail address is mj@clemson.edu .

fter years of attempts to alter the
requirements or exempt certain services, the AICPA
accounting and review services committee (ARSC) has issued
an exposure draft that seeks to make fundamental changes in
compilation engagements. The December 31, 1999, ED would
revise Statement on Standards for Accounting and Review
Services (SSARS) no. 1, Compilation and Review of
Financial Statements, which established performance
and reporting standards for compilation and review
engagements. Previous auditing standards required
accountants to add a disclaimer to the unaudited financial
statements they were associated with. Exhibit
1 provides an overview of the changes the new ED
proposes.

WHY FIX IT?

SSARS
no. 1 was supposed to establish a minimum level of service
for unaudited financial statements of nonpublic entities. To
accomplish this, there is a trigger in paragraph 7 that says
that, “The accountant should not submit unaudited
financial statements of a nonpublic entity to his or her
client or others unless, as a minimum, he or she complies
with the provisions of this statement applicable to a
compilation engagement. Submission of financial statements
is defined as presenting to a client or others financial
statements that the accountant has (a) generated ,
either manually or through the use of computer software, or
(b) modified , by materially changing account
classification, amounts, or disclosures directly on
client-prepared financial statements.” (Italics have been
added for emphasis.) This means that if the accountant
generates a financial statement or modifies a
client-generated financial statement, he or she has
“submitted” a financial statement, triggering the need to
comply with the performance and reporting standards in SSARS
no. 1.

Although this trigger effectively established
a minimum level of service, in the years since SSARS no. 1
was issued, the accounting profession, the competitive
environment and technology have all changed. These
progressive changes have led to problems for practitioners,
including deciding whether or not SSARS applies (see case
study 1). Many times an accountant is forced either to
compile financial statements or violate the SSARS
professional standards.

Case Study 1

To Apply SSARS or Not, That Is the
Question

A client asks for help
finding a problem in an income statement that he
or she has just printed—net income just doesn’t
“look right.” You sit down and begin to review the
prior month’s entries in the client’s computerized
accounting database and notice that four checks
totaling $15,000—a material amount—were coded
incorrectly as “repairs and maintenance.” Based on
your close association with the client and your
knowledge of the prior month’s activities, you
know the checks should have been coded as
“leasehold improvements.” To solve the problem you
simply change the account classifications and log
out of the software.

Did you just “submit”
financial statements? In our opinion, you did,
because you materially modified the
client’s financial statement by changing account
classifications (paragraph 7 of SSARS no. 1). Did
you intend to compile the financial statements?
Probably not. Must you now compile the
client’s financial statements? According to SSARS
no. 1, you must.

What if, instead of going
to the client’s office, you made the same
modifications on a disk in your office or by
modem? In our opinion, the answer would be the
same; you submitted financial statements and now
you must compile those statements.

The other problem
accountants face derives from market influences. As client
relationships change, many practitioners feel constrained by
the requirements of SSARS no. 1. There are instances when a
client needs financial statements solely for management
purposes. Yet SSARS no. 1 requires accountants to perform a
compilation engagement and issue a report on the financial
statements even if neither the client nor the accountant
believes it is necessary.

A NEW APPROACH

Most
of the ideas proposed during the past 22 years involved an
exemption from SSARS no. 1, including exemptions for
management-use-only financial statements, interim financial
statements and computer-generated financial statements. Each
of these ideas met opposition from most of the accounting
profession. In the new ED, ARSC has taken a different
approach: Rather than create an exemption from SSARS no. 1,
the committee rewrote the statement to recognize the
realities of the accounting profession today.

SSARS
no. 1 has always contained performance and reporting
standards for compilation engagements. The ED does not
change the performance standards. The accountant must still

Have or obtain a general understanding of the
accounting principles and practices of the industry in
which the client operates.

Have or obtain a general understanding of the client’s
business.

Obtain more information if the data the client supplies
appear to be incorrect, incomplete or otherwise
unsatisfactory to compile the financial statements.

Read the compiled financial statements and consider
whether they are appropriate in form and free of obvious
material error.

The reporting standards also
have not changed. They provide rules for

The
form of a standard compilation report.

Reporting on financial statements that omit
substantially all disclosures.

Reporting when the accountant is not independent.

Reporting when there are departures from GAAP or an
other comprehensive basis of accounting (OCBOA).

The ED does make two modifications that

Change the definition of “submission of financial
statements.”

Add communication options in certain circumstances.

ARSC decided that although the trigger could be
confusing, it still served the valuable purpose of ensuring
a minimum level of service on financial statements the
accountant generated and presented to the
client and should remain. However, the committee thought
modifying the definition of submission would solve
most applicability problems. It now defines submission of
financial statements as “presenting to a client or third
parties financial statements that the accountant has
generated either manually or through the use of computer
software.” Although the revised definition may create a
loophole for accountants who want to avoid doing a
compilation, ARSC decided the change was the best way to
address today’s technological environment and still retain
the trigger.

The second change involves
communication options. The compilation report has long been
the vehicle an accountant uses to express his or her degree
of responsibility for the financial statements to the
statement user. ARSC thought there should be other ways of
communicating the same information under limited
circumstances—for example, an engagement in which the client
and accountant do not expect third parties to use the
financial statements.

In such an engagement, the
accountant could compile the financial statements and have
three different ways to explain the accountant’s role in the
engagement:

The standard compilation report.

An engagement letter signed by management.

A letter addressed directly to management.

The two new options—the two letters—would contain much
the same information as a standard compilation report but
would simply be in a different format (see the sample
engagement letter in exhibit
2 ). To learn how accountants might use these options
in practice, see case study 2.

Case Study 2

There Is No Longer a Question

Assume the same scenario as in case
study 1, except you are now practicing under the
new SSARS no. 1 and have a signed engagement
letter with the client. Each month you go to the
client’s office and make certain “corrections and
adjustments” similar to those in case study 1 to
produce financial statements for management’s use
only. (Per your understanding with the client, the
client will not make these financial statements
available to third parties.)

Since you are
complying with the performance standards
(understanding the client’s industry,
understanding the client’s business, taking
certain actions if the information appears to be
incorrect and reading the compiled financial
statements) and you have already communicated with
the client via an engagement letter, you are in
full conformity with professional standards and
are providing exactly what the client has
requested in an effective and efficient manner.

You are no longer required to attach a
compilation report to the financial statements,
although that option is still available. You have
instead communicated much of the same information
in the engagement letter. Had you attached a
compilation report, you would have had to identify
all known departures—measurement and
disclosure—from GAAP or OCBOA. Through the
engagement letter you have indicated that material
departures may exist without having to
specifically identify them. Because the financial
statements are intended for use only by those who
can put the information in the proper context
(nonthird parties) specific identification is not
necessary.

NOT NEW, BUT DIFFERENT

The ED does not create a new type of engagement.
According to SSARS no. 1, compilation of financial
statements is defined as “presenting in the form of
financial statements information that is the representation
of management (owners) without undertaking to express any
assurance on the statements.” ARSC did not change this
definition—the financial statements are compiled in
accordance with the performance standards whether they are
accompanied by the standard report or by one of the new
atlernatives described above.

The ED defines third
parties as “all parties except for members of management who
are knowledgeable about the nature of the procedures applied
and the basis of accounting or assumptions used in the
presentation of the financial statements.” Note that this is
a definition by exception—it starts by assuming that
third parties includes everyone, except certain
members of management. Under this definition, some members
of management could be considered third parties (those who
are not knowledgeable about the entity’s accounting
matters).

Some who read this proposal will say that
all such financial statements will end up in the hands of
third parties. While this could happen, ARSC thought this
was an issue between the practitioner and his or her client.
If the client represents to the accountant that he or she
will not make the financial statements available to third
parties yet does just that, the practitioner has a larger
problem to deal with than complying with SSARS. ARSC
recommends that accountants exercise some caution in
selecting and retaining clients and recognize that
restricted-use compilation engagements may not be
appropriate for all clients.

Exposure Draft on Business
Valuations

ARSC also issued another
exposure draft on December 31, 1999, Financial
Statements Included in Written Business
Valuations. Financial statements an
accountant includes in written business valuations
frequently contain departures from GAAP or an
other comprehensive basis of accounting (OCBOA)
because the purpose of such financial statements
is solely to help develop and present the value of
an entity. ARSC issued this ED to exempt financial
statements included in written business valuations
from SSARS no. 1 because users of these statements
do not require the statements to conform with GAAP
or an OCBOA.

The proposed statement

Exempts from SSARS no. 1 historical
financial statements and “normalized” financial
statements included in a written business
valuation.

Defines normalized financial statements
as historical financial statements that
have been adjusted to make the financial
information meaningful so an accountant can
present and compare the financial results of one
entity with those of a comparable entity as part
of a business valuation engagement.

The proposal was modeled after SSARS no. 6,
Reporting on Personal Financial Statements
Included in Written Personal Financial Plans,
which exempts personal financial statements
from SSARS no. 1 if the client or accountant does
not use the statements to obtain credit or for any
purpose other than preparing a written personal
financial plan.

A copy of the ED is
available on the AICPA Web site (www.aicpa.org).
Comments on any aspect of the ED are encouraged
and can be sent to Sherry Boothe, Audit and Attest
Standards, File 2000, AICPA, 1211 Avenue of the
Americas, New York, New York 10036-8775 or
e-mailed to Sboothe@aicpa.org
. The deadline for comments is June 9, 2000.
The statement would be effective upon issuance.

PROVIDING QUALITY SERVICE

There have been several
attempts to bring SSARS into conformity with today’s
accounting profession. Exhibit
3 compares the current ED to one ARSC issued in 1995
to address the problem. Although the 1999 proposal makes
changes in SSARS no. 1, it retains the best of what has
always existed. SSARS no. 1 still embodies the traditional
compilation, but ARSC believes that the proposed changes
align the standard with the CPA Vision and equip
practitioners to serve their clients well into the
twenty-first century. An accountant now will be able to use
his or her professional judgment about how to communicate
with the client and provide quality service accordingly.

A copy of the ED is available on the AICPA Web site
(www.aicpa.org). Comments on any aspect of the ED are
encouraged and can be sent to Sherry Boothe, Audit and
Attest Standards, File 2000, AICPA, 1211 Avenue of the
Americas, New York, New York 10036-8775 or e-mailed to Sboothe@aicpa.org .
The deadline for comments is June 9, 2000. The proposed
effective date of the revision is for financial statements
submitted on or after September 30, 2000.

Plain Paper
Revisited

For more than two decades
the accounting profession has debated whether to
allow CPAs to prepare so-called plain-paper
financial statements for management-only use. The
term “plain paper” meant CPAs would not have to
put their name on bare-bones statements that were
intended only for internal use.

To allow
CPAs to issue plain-paper financial statements
would have required major revisions to SSARS no.
1, Compilation and Review of Financial
Statements. The AICPA issued SSARS no. 1 in
1978 at a time when the profession was concerned
about shielding members from legal action. The
statement set compilation as the lowest level of
service for financial statements in the belief
that there was no way CPAs could be certain their
clients would not show internal-use-only financial
statements to third parties.

In September
1995 the plain-paper debate led to the exposure
draft Assembly of Financial Statements for
Internal Use Only. It provided an exemption
from SSARS no. 1 for internal-use-only financial
statements and would have created a fourth level
of service—assembly—in addition to audit, review
and compilation. In issuing the ED, the AICPA
accounting and review services committee (ARSC)
acknowledged that SSARS no. 1 made it difficult
for CPAs to provide nonpublic clients with needed
services in a timely, cost-effective manner. ARSC
said many such clients do not need financial
statements that comply in all material respects
with GAAP—or an other comprehensive basis of
accounting—to manage their businesses.

In
August 1997 the profession was still holding
public hearings to debate whether SSARS no. 1
should be revised to exempt CPAs from having to
compile financial statements in certain situations
and instead permit them to issue plain-paper
financial statements. Plain-paper supporters
argued that requiring a compilation ignored client
needs at a time of rapid technological
advancement. Many clients did not want to pay for
a compilation when management-only financial
statements could do the job. In addition, many
practitioners were already violating the spirit,
if not the letter, of SSARS no. 1 by putting
together computer-generated financial statements
and having the clients push the buttons that
printed them. Others argued that changes were not
necessary because CPAs already had—but did not
understand—the options under existing standards
that would allow them to provide clients with
timely and cost-effective compilation services.

The 1995 ED never reached final form. In
issuing its latest ED in December 1999 to amend
SSARS no. 1, ARSC acknowledged the last five years
have brought changes to the services clients ask
CPAs to perform. Low-cost software means even the
smallest entity can prepare its own financial
statements. Despite this, many nonpublic companies
ask their CPAs to prepare management-only
financial statements. The 1999 ED adds
communication options to SSARS no. 1 to enable
CPAs to use their professional judgment in
responding to client needs.